Parents Lose Tax Deduction Worth $20,000

December 07, 1985|By Robert Bruss.

Garland and Louise operate a cattle ranch and a farm equipment sales business. They employ their sons, Dusty and Gary, as mechanics and salesmen. As partial payment for services rendered, Garland and Louise gave Dusty and Gary separate land parcels worth about $10,000 each on which they constructed their homes.

But the IRS denied Garland and Louise a $20,000 tax deduction for the land transfers as a business expense because the deeds to the properties were not recorded until after the IRS began investigating.

Also, the business financial records failed to reflect the land payments to Dusty and Gary for their sales and mechanical work. The Tax Court agreed with the IRS, denying the deductions due to sloppy bookkeeping for the payments (Farrow, T.C. Memo, 1985-518).

-- A taxpayer sold his principal residence and used the cash proceeds to buy tax-exempt municipal bonds. Then the taxpayer purchased a new principal residence and obtained a new mortgage to finance the purchase. Although the taxpayer reinvested little or no cash from the home sale into the replacement home, the IRS said the mortgage interest on the new home is fully tax deductible.

This situation is a classic example of how to sell a principal residence, invest the cash proceeds in nontaxable assets (municipal bonds), and defer the profit tax (thanks to the residence replacement rule of IRC 1034) while deducting the mortgage interest on the new home (IRS Letter Ruling 8530024).

-- John agreed to lease his land to Larmar for $10,800 annual rent. Larmar also has the right to buy the land for $180,000 anytime during the next 99 years. The IRS felt this was really a sale rather than a lease and assessed John a $51,367.27 tax on his $144,180 profit. But John argued this was not a sale but rather an installment sale.

The U.S. Court of Appeals agreed with the IRS that this long-term land lease was really a taxable sale. In an interesting twist, the court also applied a six-year statute of limitations to assess penalties (instead of the normal three years) because John`s income was understated by more than 25 percent (Burbage, 56 AFTR 2d 85-6119).